11 November 1999

The New Business Tax System: Stage 2 Response

I am announcing today the second stage of the Government's response to the recommendations of the Ralph Review of Business Taxation. These measures, along with those already announced, will provide Australia with a modern, competitive and fair business tax system. These measures overall raise additional revenue and will balance off tax reductions previously announced in stage one.

Integrity measures

The Government will adopt measures recommended by the Review to contribute to the fairness and equity of the tax system. These include:

  • Limiting the extent to which non-commercial losses can be used to reduce the tax paid on other income. Non-commercial losses arise where taxpayers incur expenditures that are constructed as business related and therefore deductible, even though they are unlikely to make a profit and the expenditures do not have a significant commercial purpose. A series of criteria will be introduced to help ensure that only losses arising from commercial activities are deducted from other income. This measure will commence from 1 July 2000 (Attachment A).
  • Restricting the ability of individuals to reduce tax by diverting the income they earn from their personal services to an entity (a company, trust or partnership). Known as the 'alienation of personal services income', this undermines the income tax base and raises significant equity issues. The proposed approach will treat the income of an entity that is earned through the provision of personal services as the income of that individual for tax purposes. The provisions will not apply where the services are provided in the manner of a personal services business. This measure will commence from 1 July 2000 (Attachment B).
  • Requiring that prepayments in respect of 'tax shelter' arrangements be deductible over the period during which the services are provided rather than being immediately deductible. This measure will help address the problem of tax avoidance through participation in 'tax shelter' arrangements. It will apply as from the time of announcement, although it will exclude prepayments where the taxpayer is irrevocably committed under a contractual obligation entered into prior to the time of announcement (Attachment C).

In addition other measures will be introduced to improve the integrity of the tax system. The general anti-avoidance rule in the income tax legislation (Part IVA) will be improved and its operation streamlined. The changes will result in more effective anti-avoidance measures and will commence from the time of announcement (Attachment D). A measure to deny for tax purposes losses on certain interposed companies will also apply with immediate effect (Attachment E).

Measures will also be introduced to make the dividend streaming and franking credit trading rules more appropriate by reducing the holding period and raising the exemption for small transactions from $2000 to $5000 (Attachment F).

Responding to globalisation

Steps will be taken to ensure that Australia receives a fairer share of tax paid by multinational enterprises. In addition, measures will be introduced so that Australian businesses are not hindered from expanding overseas and that Australia becomes a more attractive investment destination. Some of the measures include:

  • Strengthening the thin capitalisation rules to prevent multinationals (both foreign and Australian based) from reducing their Australian tax by allocating a disproportionate share of debt to their Australian operations.
  • Reforming the taxation arrangements of foreign expatriates to prevent double taxation on foreign investments but to ensure that tax on Australian income is collected.
  • Improving Australia's double taxation agreements so as to improve the competitiveness of Australian businesses offshore.
  • Providing imputation credits for foreign dividend withholding tax so as to assist Australian firms that are expanding overseas.
  • Strengthening the rules for foreign trusts in order to counter tax avoidance.
  • Removing the ability of non-residents to avoid Australian capital gains tax by disposing of interposed entities.

Consistent with the Ralph Review recommendations, a number of important international tax issues will be subject to further review, including a comprehensive review of the foreign source income rules, and the redrafting and redesign of the international tax legislation (Attachments G, H and I).

Implementing the unified entity regime

As outlined in the Government's 21 September announcement on business tax reform, the consistent tax treatment of trusts and companies will commence from 1 July 2001. The commencement of entity taxation was deferred in recognition of the current demand on business associated with the need to address Y2K compliance needs and the introduction of the GST. The following measures will be introduced to assist with the introduction of entity taxation:

  • Simplified and consistent ongoing relief will be provided for rollovers of assets, or the transfer of an entire business, from an individual, partnership or joint venture of individuals to a company or fixed trust where underlying economic interests in the assets or business remain the same.
  • Transitional relief will be available for rollovers of all assets from a fixed trust to a company provided that all assets are transferred on the same date and the fixed trust ceases to exist after the transfer is complete, and similar provisions will apply for rollovers from a company to a unit trust that will be taxed under the CIV regime, where underlying economic interests in the assets or business remain unchanged.
  • Consultations will be held with the States and Territories with the objective of removing any tax obstacles to entity restructuring.

Attachments J and K provide more details.

Improving the operation of the tax system

I am also announcing two measures to improve the operation of the tax system.

  • The Government has decided to implement, from 1 July 2001, the uniform capital allowance provisions recommended by the Review. The new provisions are well developed and have been released in exposure draft form. Reforming the capital allowance provisions will simplify the tax law and unify the taxation treatment across the range of depreciating investment assets, including capital expenditures incurred by the mining and resource sectors that are currently subject to allowable capital expenditure provisions. The new legislative framework will address blackhole expenditures and remove many anomalies - for example under the existing law deductions can be denied to taxpayers incurring the expenditure where for technical reasons they do not legally own the asset (Attachment L).
  • With immediate effect, the Government has decided to provide capital gains or balancing charge rollover relief where a taxpayer disposes of property in circumstances where a private acquirer has statutory recourse to compulsorily acquire an asset. This measure will address a long-running inequity in the tax system. It will apply, for example, where land may be subject to a mining lease or a private utility has recourse to a statutory power to acquire and the vendor has little choice but to sell (Attachment M).

The Government will undertake consultation with interested parties to finalise the detail of the Government's decisions outlined above.

High Level Reform and ongoing consultation

A major recommendation of the Ralph Review was high level reform of the concepts underlying business taxation - commonly referred to as Option 2. The Review recommended that the existing law based on legal definitions of income, which is complex and inconsistent, be replaced with a new approach to calculating taxable income based on cashflow/tax value.

The Government sees considerable merit in the high level reforms proposed by the Review and has given in principle support to their introduction. However it recognises the importance of developing a workable system that can be implemented with minimum disruption.

The Government also supports in principle other recommendations, including those related to the taxation of buildings and structures, financial arrangements and leasing and rights.

The Government will be consulting on the development of the recommendations which have been supported in principle. To this end, a working group involving representatives of the business community and officials will be established to develop the cashflow/tax value approach. Mr Dick Warburton, Chairman of the Business Coalition for Tax reform, will lead the business representation in these consultations. The objective would be to progress the practical implementation of this approach such that it could be ready by 1 July 2001 (Attachment N).

Board of Taxation

As indicated on 21 September, the Government has accepted the Review's recommendation for a more integrated and consultative approach to business tax. In particular, the Government will be establishing a non-statutory Board of Taxation and appointments will be announced shortly.

Fiscal impact of the measures

The revenue raised by the measures announced today is such that the overall impact of business tax reform will be revenue neutral. The revenue impact of the measures is attached and, compared with the previous figuring on business tax reform, incorporates additional revenue from the integrity measure affecting tax shelters (Attachment O).